Screening for Promising Growth Stocks
A growth stock investor looks to buy shares in a company whose earnings are expected to grow at a rate greater than the overall market. A growth stock typically will not pay a dividend as these funds are reinvested in the company to fuel its expansion. Growth companies are often found in technology industries and have expectations of increasing profits that entice investors to bid their valuations to high levels. The challenge for the growth investor is in finding stocks with solid growth prospects and share prices that still offer opportunity for appreciation.
Growth Investing Objective
Investors in growth stocks are willing to accept a higher level of risk for the potential of greater returns. Growth stocks usually have high price/earnings (P/E) ratios, indicating the market’s opinion about the future earnings potential of the company. Growth investors are willing to forego income (in the form of dividends) in favor of anticipated capital appreciation.
The Risks of Growth Stock Investing
While growth stock investing can provide great rewards, there are inherent risks to the strategy. If the company does not grow as anticipated or if the entire industry falls out of favor, the stock price will suffer. It’s also worth noting that growth stocks struggle more than others during times of economic turmoil.
Screening for Growth Stocks
Many growth investors believe that the use of a stock screener is the best way to find good growth candidates. The following parameters are often used as part of the growth stock screening process:
Market Capitalization: The “market cap” measures the size of the company and is calculated by multiplying the share price by the number of shares outstanding. In order to screen out very small companies (to minimize risk), the minimum market capitalization can be set to $500 million.
Share Price: A minimum share price of $5 can be set to filter out the most volatile stocks.
Revenue Growth: The revenue is simply the amount of sales the company generates over a given period of time. By definition, a growth stock experiences revenue growth at a pace greater than its industry or the overall market. A five-year growth rate of at least 15% is often the norm for growth investors.
Estimated Earnings Growth: Because stock prices are really based on future earnings expectations, it is important to look for significant upside potential on this measure- growth investors often look for a minimum of 15% over the next five years.
Current Ratio: The current ratio provides an indication of whether the company will be able to pay its debts in the coming year. Setting the current ratio to a minimum of 1.5 can filter out those companies that are strapped for cash.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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